The solution to black money is not demonetisation but detaxation

The government had expected that over 4 lakh crore of black money would be ‘extinguished’ from circulation, thus lightening the debt burden on the RBI which could then have passed this windfall onto public sector banks stressed by bad loans, or non-performing assets (NPAs).THE ECONOMIC TIMES | January 06, 2017, 16:01 IST

Before the finance ministry could say ‘demonetisation’, all the black money had already been converted to white.

The government had expected that over 4 lakh crore of black money would be ‘extinguished’ from circulation, thus lightening the debt burden on the RBI which could then have passed this windfall onto public sector banks stressed by bad loans, or non-performing assets (NPAs).

However, this has not happened. Almost all the currency that was demonetised has come back into open circulation as white money.

How did this happen? One of channels for converting black money into white are shell companies. A shell company is a registered company with an official address but which conducts very little if any business, thus it is not liable to pay tax.

When black money needs to be made white, a shell company will show some business transaction through which it earned a small profit, below the taxable limit. This money is then paid to another company, or to an individual, in the form of a consultancy fee, or other professional charge.

The extent of this laundering process is vast.

According to a report based on information obtained from the Registrar of Companies, there are over 1,33,000 such shell companies, or drop-box companies, in India, with Kolkata being home to many of them.

A single one-room office in New Delhi’s Nehru Place has no fewer than 75 such companies operating from it.

These companies are legitimate entities, even if the clandestine business they conduct – turning black money into white – is not. Come demonetisation, hell or high water these companies will continue to operate, endlessly turning black into white.

So the solution to black money is not – and can never be – the ‘surgical strike’ of demonetisation.

What is the root cause of black money? The obvious answer is dishonesty.

But what causes people to be dishonest are taxes, which they want to avoid.

Do away with personal income tax and we’ll do away with a significant amount of black money, as all personal earnings will be tax-free and fully legitimate.

Scrapping personal income tax – detaxation, to coin a word — wouldn’t cost the public exchequer a lot, as less than 5% of the population pays personal income tax.

Any marginal revenue loss would be more than made up by an overall tax like the long-stalled Goods and Services Tax (GST).

In black-and-white terms, detaxation might be the only permanent solution to black money.

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